Which Investment Accounts to Access First When Retired
Once retirees need investment withdrawals to supplement their Social Security and pension payments, they need to decide which type of account to access first. Strategies will vary depending upon the goal. Potential goals include minimizing taxes, maximizing an inheritance and avoiding higher Medicare premiums.
The type of account determines the tax consequences of making a withdrawal. Account types include:
- Tax deferred (TSP, 401k, IRA, 403b) – No taxes are due until withdrawal is made. Withdrawals are taxed as ordinary income.
- Tax free (Roth IRA) – As long as requirements are met, there is never a tax on withdrawals.
- Taxable – Taxes are due annually on earnings and capital gains generated during the tax year. Dividends and capital gains are taxed at a lower rate than interest income.
There is no definite order for which accounts to access first to generate retirement income. Different priorities and circumstances require different strategies.
As a hypothetical example, if minimizing taxes is the priority, consider accessing accounts in this order:
- Spend income first (pensions, Social Security, fixed annuities and RMDs).
- Withdraw bank funds that exceed the amount needed for an emergency fund. Income from bank accounts is taxed at highest marginal rate and there are no additional taxes when the funds are withdrawn. Do not spend down your emergency fund.
- Then turn to taxable investments.
- Stop reinvesting dividends, interest and capital gains in taxable accounts. That income will be transferred to a Money Market fund.
- Once funds in the Money Market account are used, sell shares to generate the additional income needed.
- Then turn to tax deferred accounts, including 401(k)s, TSP, IRAs, 403(b)s, etc.
- These accounts are tax deferred and you usually want to continue the deferral as long as possible.
- Withdrawals of deductible contributions and earnings are taxed as ordinary income tax rates.
- Roth accounts need special consideration. Funds are not taxed when withdrawn, so you might use them first. However, there are no Required Minimum Distributions for Roth IRAs, so you might use them last.*
Of course, there are other possible strategies.
This material is meant for illustration and/or informational purposes only and it is not to be construed as tax, legal, financial or investment advice. Arthur Stein and Arthur Stein Financial, LLC are not authorized to give legal or tax advice. For information on your specific situation, please consult a tax advisor regarding any tax implications and an attorney for legal implications.
*Withdrawals from a Roth IRA prior to age 59 1/2, and/or prior to the mandatory 5 year holding period, may be subject to a penalty tax.